Describe the principles and processes for setting executive compensation?
Agency theory, tournament theory and social comparison theory are the 3 alternative theories that explain the principles and processes for setting executive compensation. Different individuals and groups participate in setting executive compensation. They include compensation consultants, compensation committees, and boards of directors; each play a different role in setting executive compensation. Executive compensation consultants usually propose several recommendations for alternate pay packages they are often employed by large consulting firms. A board of directors represents shareholders’ interests by weighing the pros and cons of top executives’ decisions. There are approximately 15 members on the board. They give final approval of the compensation committee’s recommendation. Board of directors members within and outside the company make up a company’s compensation committee. Outside board members serve on compensation committees to minimize conflict of interest. Compensation committees perform three duties. First, compensation committees review consultants’ alternate recommendations for compensation packages. Second, compensation committee members discuss the assets and liabilities of the recommendations. Third, the committee recommends the consultant’s best proposal to the board of directors for their consideration. Under agency theory, shareholders delegate control to top executives to represent their ownership interests; however top executives usually do not own majority shares of their companies’ stocks. Shareholders negotiate executive employment contracts with executives to minimize loss of control. Tournament theory casts lucrative executive compensation as the prize in a series of tournaments or contests among middle and top level managers who aspire to become CEOs. According to social comparison theory individuals needs to evaluate their accomplishments and they do so by...
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